Well the 10 year treasury has popped today to .75% which takes it to a level we haven’t seen since May.
Thus far a 5 or 6 basis point move has not been detrimental to pricing in income securities–and likely won’t be unless the ‘pop’ is more like .125 to .25% in a single day–then you are going to create some ‘nervous nellies’.
On a historical basis it has taken a jump of at least 1/8% for anyone to even notice–and more like 1/4% to start to see a bit of damage to preferred and baby bond pricing–numerous days with movements in yields a few basis points higher will be generally well tolerated.
On the other hand with these super low coupon issues being sold lately the reaction to rates moving higher could surprise us in these particular issues. No one wants to be holding a coupon of 3.875% when rates move higher.
So we will see what happens in the next few days–I suspect this is a very temporary move higher in yields–simply based on stimulus possibilities.
Bring on a panic…
I see 10 year at 1.471 on 2/21. A week later 1.127….a week later 0.76…a week later it hit 0. 39 but closed 0.95 a week later it touched 1.266 but closed 0.938
Apr 21= 0.51…6/5 hit 0.95….8/6 0.504…. Today 0.72 ish……
None of that matters to most of us. A Gary shilling remains long treasuries, he cares. Most anything tied to Treasuries is yielding so low its just tiddly winks.
If you Prefer, Everything is tied to Treasuries, and the sensitivity to changes in rates increases as yields fall and duration rises.
Lets say you have a Baby bond maturing in 20 years, trading at $26 and a coupon of 5%. The duration is 12.9 years, and if treasuries rise 1% from 0.75% to 1.75% you will lose 12.75%.
Directions matter but with yields to call of 3.5 to 4.5 on pfds…. I have a hard time seeing direct correlation to 10 treasuries.
Prices move in pfds more based on corporate finances, governance and inflation outlooks….then a direct spread to treasuries
ChrisW, think about what you wrote, and then try some math. I have a rudimentary YTC calculator set up in Excel, which gives a decent approximation vs. the full-blown process using all future cash flows.
$26 * 0.8725 = Price of 22.685 after the +1% change in rates, per your assumption. That would make the yield off price = 5.51% vs. 4.81% priced at 26, a change of -70 bps.
Similarly, the estimated YTC would go from 4.71 to 5.76, or +105 bps. I find it hard to believe that the market would not react with the YTC spread vs. UST10 (if such a thing actually exists) tightening if for no reason other than the fact that the bond has gone from a premium to a discount. The principle in play is called ‘convexity’, and its relationship to duration for fixed income is similar to the relationship of gamma to delta in options. Investopedia has a nice chart here:
https://www.investopedia.com/articles/bonds/08/duration-convexity.asp
Others on the board with more experience may have real-life examples of where baby bonds and preferreds now at a $1 premium with similar coupons traded pre-Covid, but I can tell you that when I look at charts, I see preferreds like CFG-D that are trading at around the same level as their pre-Covid highs.
We know that the 10 Y was at a much higher level in early January, roughly 100 bps, so by your logic an instrument with a 6.35% coupon that is not callable for another 3.5 years should be trading significantly higher now than it did in January. And, we certainly know that the emotions of the market and liquidity needs can overwhelm any math, regardless of instrument type.
ChrisW’s assumption that a rise in Treasury rates of 1% will lead to a rise in 1% of any other type of bond/preferred is not reliable. It depends on whether credit rise or fall, taxation impacts, etc.
To simplify the point on bond convexity: duration is not a fixed number regardless of the price of a bond. In fact, it changes slightly at EVERY different price. Where it gets real tricky is when a bond is trading close to or above it’s call price, at which point the duration is much lower than would be the case with a comparable non-callable bond.
In fact, the duration can be negative when a callable bond is trading over the call price. That means if the bond’s discount rate rises slightly, the price will actually go up instead of down. The logic is that the issuer is now less likely to call the bond because it would have to pay a higher coupon on a new issue and a callable bond that has just become less likely to be called is now more valuable. As the discount continues to rise, the duration which eventually turn positive again and the bond price will start falling.
Long story short – callable bonds/preferreds that are trading near the call price have very low duration and thus are not very sensitive to modest moves in discount rates (up or down). Credit risk still applies, of course, so most of the volatility you see in such issues is related to that, not changes in pure interest rates (i.e., Treasury yields.)
Over several decades preferred interest rates had the best correlation to Corporate Baa yields, not US treasuries. I have not updated it in several years, but I used to run the correlations myself on several hundred preferreds versus UST 30 day, 90 day, 1 YR, 5YR, 10YR, 30YR, Corporate AAA, and Corporate Baa. Some preferreds had better correlation to one of the UST’s, but the majority of them correlated best to Corp Baa’s.
A simple “proof” of this is the recent March-April downturn. UST rates all went lower, while nearly all preferreds that traded with higher yields, aka lower prices. So if you want to use any of the UST’s, you will have to ignore this data, plus the few other times we have seen broad corrections in preferred prices. Note the “Grid specials” that did NOT trade were generally more resistant to the recent downturn, so they might not fit any interest rate model very well. Pretty tough to prove the validity of a model when an issue only trades say twice a year.
I would suggest running at least a few correlations with data through today to validate any model. See if the data supports a “UST 10 Year yield rises by X, then preferred XYZ yield rises by Y.” See if it proves out or not.
It hit .90 on June 4?
You’re right Potter–a quick up and down for a few days.
After a few down days on decent eREIT, it seems that quality eREIT, e.g. WPC and leveraged RQI and AWP are recovering (as compared to VNQ). UTG a small leveraged CLF and utility index fund (e.g. VPU and XLU) are also recovering in the yield hungry world. Ditto for the best of BDC’s. Several articles on NLY and NLY-I, presumably the safest of the mREIT. Not sure that this positive market action is just before the storm. Tim, I thank you so much for your Herculean work on your sortable spreadsheet, especially in upcoming termination of CDx3 with Mr. Doug Le Du’s retirement. BTW, all Gridbird’s and your picks are solid but seems pricey at this juncture. I quickly stopped selling SMNLP, illiquid and safe. John